Question

Suppose that a commodity’s forward prices for 1 year and 2 years are $132 and $137. The 1-year effective annual interest rate is 4.4%, and the 2-year interest rate is 5.0%. You will pay a fixed rate of $134.43187 in a 2-year swap and receive the floating rate. Now suppose that just after you enter into the contract, the 1-year and 2-year interest rates each rise by 25 basis points. What is the value of your swap position after this change? (PLEASE SHOW YOUR WORK, STEP BY STEP). Thank you :)

Selected Answer:	a. $–0.0055 (CORRECT ANSWER)
Answers:	a. $–0.0055
	b. $–0.0163
	c. $0.0000
	d. $0.0055
	e. $0.0163

Answer 1

The interest rates for 1 and 2 year will be 4.65% and 5.25% after the increase

After one year, $134.43187 will be paid and $132 will be received

So, net amount paid = $2.43187

Present value of the amount paid = 2.43187/1.0465 = $2.323813

After 2 years, $134.43187 will be paid and $137 will be received

So, net amount received = $2.56813

Present value of the amount received = 2.56813/1.0525^2= $2.31832

So, Net value of swap = Present value of the amount received-Present value of the amount paid

= 2.31832- 2.32813 = -0.005496 or $-0.0055

So, value of swap position after change is $-0.0055 (a)